"Our
house is a very, very fine house,
It's got two cats in the yard,
Life used to be so hard..." - Crosby, Stills,
Nash and Young - Our House

I'm sure you
did the same thing. A few years ago, when you
first heard the name, you thought to
yourself, "I've heard of them. I buy
their tomatoes and red peppers at
Safeway." C'mon, admit it. You did to.
And then when you heard that they were a
technology company and they spelled House
like this (Haus), you thought to yourself,
"What a dumb name!" Yes you did. Me
too.

I'm sure you
did the same thing. A few weeks ago, when you
saw HotHaus CEO Ross Mitchell at the BC TIA
Awards Dinner, you said, "He's a bit
cocky! He's crowing about how simple his
technology is, that it fits on one floppy
disk, and that everyone in telecommunications
wants it." But you thought he was a bit
self-deprecating too. And you wished him luck
under your breath.

I'm sure you
did the same thing. A few days ago, when you
picked up the Globe or the Post or the Sun
and you pulled a Roger Rabbit (you know, chin
hits ground, eyes pop out three feet,
attached only by the optic nerve to your
body). Yeah, me too. Four hundred million
dollars! Repeated. Repeated again, slowly.
Reached for the phone. Called someone, anyone
and said, "Didja see that? HotHaus
bought for four hundred million freakin'
dollars!"

For those of
you just waking up this week or for those
foreign viewers, Broadcom (NASDAQ: BRCM) bought HotHaus
Technologies for US$280M or roughly $414 M
CDN in an all stock deal.

I'd just
like to start by welcoming British Columbia
to the map, thanks to Ross, his 60 employees
and their investors, most notably Working
Opportunity Fund. {The map is one that has
not really included Canada much over the past
few years, let alone BC. Recent additions
outside of Northern California, Boston, New
York, Austin and Seattle include Israel and
Scandinavia. The cartographers of this map
include investment bankers and analysts in
New York, venture capitalists in the Valley
and executives at Fortune 1000 companies.
They decide who gets on the map. Ballard? Yes
it woke up the cartographers, but it isn't
information technology. PMC-Sierra? A merger,
so it didn't rate as highly on the meter.
With Creo and Pivotal ready to put BC on the
map, HotHaus has helped solidify our position
significantly} Hallelujah!

You've heard
the platitudes and read all of the articles
in the mainstream press. They are
well-deserved. HotHaus just won the Stanley
Cup of technology. I'm going to take a couple
of different tacks. Well, what did you
expect? Here's what I am going to cover:

Why so
much for a company with $4-5 million
in revenues?

What
does the deal mean for BC technology
(I've already mentioned the
"map" thing)?

Just
how much did the employees make in
this deal?

Why
did Broadcom pay so much? 100 times
revenue is a pretty steep valuation. Some
Interent IPOs don't get valued that high.
Well, only a few but it's still
staggering to think about. I have four
reasons for you.

1) Pooling
of Interest Transactions  High flying
stock gives a company a brand new currency
under US accounting rules. Calling the deal a
"pooling of interest" is another
term for merger. This is the preferred route
for IT companies to acquire, because if your
stock goes up, you negate any dilution effect
from issuing new stock to the company being
acquired and you haven't used any cash.
Technically, a merger is supposed to be
between "equals". BRCM had US$203 M
in sales in 1998. HotHaus had US$3M. Not
exactly equal. If you overlook that niggly
detail, the pooling of interest is attractive
because it allows the pooler (BRCM) to
overpay without adverse effects on its income
(For more on the debate about pooling
transactions, see http://www.upside.com/texis/mvm/story?id=37447a070). It is a well known
fact in the U.S. that pooling allows for
higher valuations than cash deals. In this
case, I would venture a guess that Broadcom
might have paid four to five times less
for HotHaus, had it been a cash deal.

2) The Buy
Each Piece of the Bigger Pie Argument 
HotHaus' software converts data, fax and
voice from traditional phone networks to
packet networks (like the Internet). Broadcom
makes chips that run broadband access gear,
cable modems and set-top boxes (actually,
they design them and someone else makes
them they are called a fabless
semiconductor company, because they lack
fabrication plants). Broadcom thinks, in the
words of Henry Nicholas, CEO, that "The
home market is the volume play for the
future". They bought Epigram a few
months back for a similar amount to HotHaus.
Epigram has chip designs to run data over the
phone lines inside your house, between
information devices, without interrupting
conversations or DSL services. Very cool. It
means you can hook up your son's PC to yours
using existing jacks in the wall and play
deathmatch Quake games while your daughter
talks on the phone. So, HotHaus has the
ability to interface between circuit switched
data and voice on the plain old telephone
system coming in to or leaving your house and
the packet switched network coming in or
leaving through your cable modem or set-top
box. Confused? Broadcom isn't. They see a day
when all of your information, entertainment
and communication needs run seamlessly
through the pipes you already have in your
home. HotHaus had a piece of their puzzle.

If the home
networking and information access market is
going to be huge, then paying $1B in small
company acquisitions now (Epigram, HotHaus,
Maverick and Armedia) might seem like small
potatoes when you own the market later. Case
in point: Everyone gasped when Microsoft paid
$425 M for Web TV in 1997. With all of its
recent investments in cable companies, like
Rogers, the strategy is starting to become
clearer. And the price will soon look like a
bargain for all the viewers tuning in through
Microsoft technology.

3) The
Competitive Protection Play  A
favourite of market leaders, like Intel. This
strategy is likened to "hush money"
whereby a large player buys out a promising
young technology to put it on a shelf so no
one else gets their hands on it. Broadcom
might have seen HotHaus as a threat, because
they would have licensed their technology to
Broadcom and all of its competitors. By
owning it and giving it to no one else,
Broadcom might get a certain advantage. This
makes a lot of sense if the technology is
protectible (i.e. patented) and would add a
lot of value to the deal.

4) The
Labour Crunch  Tough to find top
quality engineers these days, what with all
of the start-ups etc. One of the analysts
covering Broadcom noted that 80% of the 135
employees acquired were engineers (that does
not include HotHaus). The analyst suggested
that this was a huge benefit to a firm trying
to keep product development momentum. Now
imagine that you are Henry Nicholas and your
VP, Business Development walks in and says,
"I found a company that has a critical
piece of our technology map and they have 50
high quality engineers. Get this. The
engineers will be 40% cheaper going forward
because they live in Canada. And we'll get
tax credits if we keep them in Canada. What a
deal!" In today's labour market in the
US, this is a dream come true. I would think
that the value of each engineer to Broadcom
would be $5M - $10M in today's market.

Taken all
together, the value paid by Broadcom starts
to make sense.

What
does this deal mean for BC technology?
I already alluded to the fact that the US
financiers and companies will pay attention
to BC tech companies, now more than ever
before. There has not been a technology deal
of this magnitude done in all of Western
Canada. It's huge! Guess who else will
notice? The government. Yup. The feds and the
provincial ilk will pay a little more
attention. I can here it now, "Ross, you
sell-out. You gutless sham. Why would you
ever sell to the American heathen when it is
so good here in Canada? We are selling Canada
to the Americans. What will happen to our
precious culture?" You get the picture.
What the governments don't realize (or don't
vocalize) is that when a US firm buys in
Canada they stay and they grow (think EA
Canada, Seagate Software, Motorola Canada).
Then you get more taxes being paid by more
Canadians.

The real
meaning of this deal for BC technology and
the future companies is the multiplier
benefits of rich, smart technology people.
Ross and his team will eventually leave
Broadcom. They will have tons of money and,
hopefully, tons of new ideas. Others will
approach them to get "angel"
funding. I can't underline this enough. A
strong angel community and a pile of people
that have "won" in the start-up
space is the foundation of a larger
technology community. Combined with CREO and
Pivotal, there will be some fully vested
people looking to do their own successful
companies in a few years. {To all of you
folks at Pivotal, Creo and HotHaus you
have my number }

Just
how much did these guys and gals at HotHaus
make? This is the fun part. Ross?
That's easy. I bet he owned 35% of the
company. According to that assumption, he is
worth $145M today. But not all of us get to
be founder and CEO. What about the regular
employee? Assume that our example employee is
a lower level engineer (lets call him Rich)
with a $55,000 salary and 5,000 options at
HotHaus. The options are priced at $3
(assuming the last round of financing gave
the company a value of $30M CDN and 10M
shares). That means if the company value goes
above $30M, without dilution, Rich is
"in the money". Well, Broadcom just
set the value of the company at $414M. So
Rich is well rich. The company value
increased $384M or almost 12 times the last
round. When the company sold, Rich
immediately vested all options (common
practice) and was given Broadcom shares,
equivalent to the amount of money that his
option were worth. So, he now has $3 x 12 =
$36 worth of profit per option x 5,000 =
$181,000 worth of BRCM stock. Not bad, eh? I
can hear all of your wheels turning now. What
if I had 10,000 options? $362,000 Nice!

Oh, and Rich
is free to sell his BRCM stock or hold it. No
lock-up. Do you think there will be some new
cars in the HotHaus parking lot in the next
few weeks?

I want to
congratulate Ross and his team on their
achievement. Outstanding job! I have picked
up my jaw and will now look for a few more
just like HotHaus.

Responses
From Last Week -

Brent,

I'm with you
in principle, but I think you've missed a
couple of things.

1. Your
three placard holders (mainframe,
client/server, web) share something: each is
a devotee of the then CURRENT technology.
Believe it or not , there have been web
advocates since the late 1960's  when
packet switching was an arcane research
experiment. Its developers were unknown and
unsung, as are today's REAL, youthful
groundbreakers  ie those working on
optical and molecular devices.

2. Which
brings me to my second point, which is that
the critical development which permits
today's software explosion is not youthful
enthusiasm ( which has always been
ubiquitous) but affordable hardware. Everyone
seems to have forgotten this. By way of
illustration, just imagine what would happen
if $500. Student home physics kits included
fully operational, high energy particle
accelerators. Ten year olds would be pushing
the knowledge boundaries of fundamental
physics, and giving the Nobel prize winners a
run for their money. No doubt society would
then celebrate such kids' success - and
completely forget the accelerator designer
who unlocked their potential!

So let's
keep an eye out for the local kid all set to
deliver something genuinely trendsetting, eg
to finally consign mechanical memory devices
to a well deserved oblivion. He/she will
truly reward the company bold enough to look
beyond today's technology.

Keep up the
harangue.

Peter
Gellatly

Mark Anderson has talked about
designing software for kids that lets them
program at an early age (There was one such
program called Logo, but it has disappeared).
Kids will grow up creating things that blow
our minds if they get the right tools. Thanks
for writing back.

Brent,

I love the
article, scary to think someone who is
interested and makes an effort to keep up can
still fall behind due to the vast load of
info that is streaming at us. I often like to
speak with young teens and ask what they do
on the web and find it pretty amazing at how
many new technologies they are familiar with.

I read a
recent article about Silicon Valley which had
similar undercurrents, although they were
speaking about the startup process. Business
models, corporate loyalty, technologies, etc.
were being thrown to the wind. You create
more opportunities by sharing ideas and
concepts than by holding them close. It is
truly an open market for VC funding, ideas,
people, and business models (the article
neglected to mention that many people
probably got burned due to divulging info).

What I find
interesting is that it has been an extremely
successful model for the valley. So, what
does that mean when millions of these kids
(not just the few today) realize that not
only can they copy their favorite films and
music but shake up the global economic system
(not just the Internet system)? I do not
think it is a question of whether, but rather
when. Within 5 years, the majority of early
teens that have grown up with the Web will be
at a point where they will flex their
collective intuitive knowledge of this new
media. That's when the real fun will begin...

Laurie
Baggio

That's right! These kids are
sharing ideas as their currency. The Silicon
Valley works because of that. I talked about
it before. I have learned a lot from books
and magazines, but you learn more at a trade
show or conference because you are
interacting and sharing ideas. Thanks for
being a regular responder Laurie!

Something Ventured is a bi-weekly column designed to supplement the T-Net British Columbia web site with some timely, relevant and possibly irreverent insight into the industry. I hope to share some of the perspective and trends that I see in my role as a VC. The column is always followed by feedback (if its positive or constructive. I'll keep the flames to myself, thanks).